OUTPUT, STOCK VOLATILITY, AND POLITICAL UNCERTAINTY IN A NATURAL EXPERIMENT - GERMANY, 1880-1940

Why does volatility increase when output declines? The theory of inves tment under uncertainty implies that political uncertainty may simulta neously increase volatility and reduce output. Though cause and effect are typically hard to separate, the transition from Imperial to Weima r Germany offers a natural experiment because major political events l eft clear traces on stock prices. Current and past increases in volati lity are associated with output declines, consistent with U.S. experie nce. However, political events are more clearly the source of volatili ty, and the results support the view that the relationship between vol atility and output reflects the joint effects of political factors.